Bitcoin Taxes 2016: Accurately Reporting Bitcoin Usage
Editor’s note: The original introduction to this article has been replaced with one written by tax accountant Daniel Winters, which corrects some factual inaccuracies in the original.
While the IRS rules have not changed since last year, it’s important to understand how to handle the taxes on Bitcoin transactions since Bitcoin income is not tax free. Accurately reporting taxes for Bitcoin can be tricky since the IRS treats Bitcoin as property, NOT currency. Since Bitcoin is property, you need to calculate gains or losses. The number of Bitcoin users has grown significantly since 2015, and we’re republishing our 2014 articles on Bitcoin and taxes to assist the community with this important issue. This year the tax filing deadline is April 18th.
Daniel Winters, MS Taxation, MBA
Global Tax Accountants is owned by Daniel Winters, who has over 12 years of tax experience and holds both a Masters of Taxation and an MBA. Daniel has written a course for accountants about Bitcoin and has been interviewed by Bloomberg and Thomson Reuters. He has presented at the San Francisco Blockchain Conference, New York Blockchain Conference, Texas Bitcoin Conference and the New York Bitcoin Center. Daniel’s clients include the US operations of Bitmain (manufacturers of Antminers), DigitalExpress.io (Bitcoin ATMs), high volume traders, cryptocurrency miners and Ethereum developers.
His areas of expertise include the following:
- Taxation of Bitcoin and crypto currencies
- Taxation of U.S. citizens resident abroad and U.S. companies with international
- Taxation of partnerships (LLCs), S corporations and high net worth individuals
The basics of Bitcoin taxes
On March 21, 2014 the IRS issued Notice 2014-21, which describes how Bitcoin and other “virtual currencies” are treated for federal tax purposes. Under the Notice, virtual currency is treated as property, NOT currency. Though Bitcoin and other virtual currencies are a new type of capital asset, the IRS has well established rules for handling the sale of capital assets. The sale and exchange of Bitcoin is therefore treated similarly to the sale of other capital assets, such as stocks.
When you buy Bitcoin, then later sell or exchange the Bitcoin, you will have a gain or loss on the transaction. For individuals, Bitcoin which is sold after being held for more than 1 year is taxed at long-term capital gains rates, usually 15%, but a 20% rate applies to taxpayers in the top tax bracket. For individuals, Bitcoin which is sold after being held for 1 year or less is taxed at ordinary income tax rates up to 39.6%.
Unfortunately, there is NO minimum threshold for reporting Bitcoin transactions. This is consistent with stock sales – brokerage firms frequently report sales for under $1. Since issuing the notice, the IRS has updated the instructions for filing 2014 tax returns. The new instructions for reporting capital gains and losses on Schedule D specifically mention Bitcoin and virtual currency. In addition, the instructions for Form W-2, Wages, also include language describing the treatment of wages paid in Bitcoin.
Transactions in virtual currency must be reported at their fair market value in USD, therefore we need to convert the Bitcoin to USD using an appropriate exchange rate. The IRS stated only that Bitcoin must be converted into USD in a reasonable manner which is consistently applied. As we all know, Bitcoin’s price is unstable and can go up or down 10% in a day. Also, rates vary between exchanges located in different countries, and different exchanges in the same country.
So, what do we do? Choose one source for the exchange rate, and use the same source for converting ALL Bitcoin transactions in the same year.
Now we’ve covered the basics, let’s look at some examples:
1. Johnny Quinoa buys 1 Bitcoin on January 15, 2013 for $10. He sells the 1 Bitcoin on January 16, 2014 for $1,000. Johnny’s gain is computed as follows: Proceeds of $1,000 less cost basis of $10 = $990 gain. This is long term capital gain.
2. Same facts, but with a different sale date. Johnny Quinoa buys 1 Bitcoin on January 15, 2013 for $10. Johnny sells the 1 Bitcoin on December 31, 2013 for $1,000. Johnny’s gain is computed as follows: Proceeds of $1,000 less basis of $10 = $990 gain. This is short term capital gain.
So far, we’ve assumed that Johnny purchased the Bitcoin using fiat currency, then sold the Bitcoin for fiat currency. Instead, what if Johnny bought the 1 Bitcoin using 10 USD, then later exchanged the 1 Bitcoin for another virtual currency? Some would argue that this is a “like-kind” exchange and that no tax is due until Johnny cashes out to fiat. We disagree and believe this situation is treated identically to selling shares of IBM and purchasing shares of Google.
Here are the facts:
- Johnny Quinoa bought 1 Bitcoin on January 15, 2013 for $10.
- It is now January 15, 2015, and 1 Bitcoin has a fair market value of $300.
- Johnny wants to buy a new virtual currency called LowTaxCoin using the 1 Bitcoin.
- He will purchase 2 LowTaxCoins in a direct exchange using 1 Bitcoin.
These are the tax consequences:
Proceeds of $300 less basis of $10 = $290 gain. This is long term capital gain. Johnny now owns 2 LowTaxCoins. Each has a cost basis of $150 (300/2). When Johnny later sells the 2 LowTaxCoins, he will need to calculate the gain / loss on the transaction using the $150 cost basis.
Since any exchange of Bitcoin should be reported on your taxes, it is extremely important to keep good records. Fortunately, LibraTax.com can import Bitcoin transactions from many major wallets, and can even import transactions directly from a public Bitcoin address.
Working for Bitcoin
If you’re being paid in Bitcoin, it’s very possible that you will have a 2-stage calculation to accurately report your Bitcoin income.
Bitcoin is property, and for individual taxpayers Bitcoin is generally treated as a capital asset, the same as stock.
When you purchase Bitcoin, you need to record the USD value of the Bitcoin on the day of receipt. This is your cost basis. When you later sell or exchange the Bitcoin for goods or services, you need to calculate the gain or loss in USD. Just convert the amounts of Bitcoin sold into the USD value on that date, subtract your cost basis in USD and that’s the gain or loss.
Individuals who receive Bitcoin for performing services, whether as employees or independent contractors, have income equal to the USD value of the Bitcoin on the date of receipt. For employees, the income is wages and the employer should report this on Form W-2. Contractors should receive a Form 1099 and the income is subject to both income tax AND self-employment tax.
However, since Bitcoin is property, the individual also holds Bitcoin with a cost basis equal to the USD value on date of receipt. Unless the Bitcoin is immediately exchanged for USD that same day, you will need to record each transaction in which you later sell or otherwise exchange the Bitcoin, and calculate the gain or loss. This is the 2nd stage of the calculation.
For anyone being paid in Bitcoin on a steady basis, keeping track of the transactions can get complicated quickly.
Read more about calculating taxes from working for Bitcoin here.
Special thanks to Daniel Winters for providing information on Bitcoin taxes and for continuing to help the Cryptocurrency community. If you need help with your Bitcoin taxes, please consider contacting Global Tax, LLC. While it has not changed since last year, accurately reporting taxes for Bitcoin is essential for those looking to avoid an audit.
Any tax-related opinions in any part of this document or website (including any links) are not tax advice. The above is a general explanation of tax law and should not be relied upon for your individual circumstances. Tax advice cannot be provided on a general basis, and must be specifically tailored for each individual by his or her particular representative. Any user of this website should seek the advice of a competent, independent tax professional regarding that user’s particular circumstances.
In addition, any tax advice given herein (and in any attachments) is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (i) avoiding tax penalties or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed therein.
What do you think about Bitcoin taxes? Have you had any trouble with yours? Let us know in the comments below!
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